Lagarde’s Ogre Propels Nordics Down Diverging Paths: Currencies

By Lucy Meakin -
Mar 4, 2014

Nordic currencies are diverging the most in a year as traders punish Sweden for lagging behind Norway in averting deflation.

The krona has dropped 0.9 percent from its high this year on Jan. 29 against a basket of nine other developed-market currencies tracked by Bloomberg, while Norway’s krone has jumped 1.8 percent. The krona fell 3.4 percent in the past month against the krone -- the most since 2009 -- amid bets that Scandinavia’s largest economy will cut interest rates to stave off the steepest decline in consumer prices in five years.

“We’re quite bearish on the krona, and that to a large extent is driven by the deflation theme,” said Ian Stannard, the head of European currency strategy at Morgan Stanley in London. “It’s going to keep the Riksbank far more dovish than the market has been expecting. The deflation theme will probably have an impact on Norway, but not to the same extent.”

Deflationary pressures in Sweden are more extreme than that facing the 18-nation euro area to the U.S. as consumer demand struggles to recover from the deepest financial crisis since the Great Depression. International Monetary Fund Managing Director Christine Lagarde urged advanced nations in January to fight the deflation “ogre” that’s threatening the world economy, and which caused a decade and a half of sluggish growth in Japan.

Benefits Sapped

Swedish deflation is sapping the benefits of an economy that’s exceeding forecasts. The nation’s gross domestic product expanded 1.7 percent in the fourth quarter, up from 0.5 percent in the previous three months and compared with an economists’ median prediction of 0.6 percent in a Bloomberg News survey.

“There’s a divergence going on between the Norwegian krone and Swedish krona in terms of the way the central banks are positioned at the moment,” said Matthew Slade, a strategist at Nomura International Plc in London. “We still like being short krona following the stronger GDP release,” he said, referring to a bet a currency will weaken.

The Swedish krona fell to a three-month low of 1.0810 per krone on Feb. 25, and was at 1.0725 yesterday in New York. The krona slipped to 9.0106 to the euro on Feb. 21, the weakest level since December, while the Norwegian krone touched a three-month high of 8.2485 versus the shared currency yesterday.

Most Bearish

Morgan Stanley is the most bearish forecaster on Sweden’s currency against the euro among more than 30 firms surveyed by Bloomberg. The U.S. firm predicts the krona will fall about 6 percent to 9.4 per euro by year-end, compared with a median forecast of 8.55. It sees Norway’s krone falling 3.5 percent to 8.55 per euro, versus a median prediction of 8.

Riksbank policy makers discussed the possibility of cutting borrowing costs to counter low inflation at their February meeting, when they held the main rate at 0.75 percent.

Norway central-bank Governor Oeystein Olsen said last month he was “observing” the relationship between the krone and inflation, though officials pledged in December not to tighten monetary policy until summer 2015. Norway has kept its deposit rate at 1.5 percent since March 2012.

Options Traders

The krone may struggle to keep outperforming Sweden’s krona because Norway’s central bank favors a weaker currency to re-balance an economy that relies heavily on oil exports, said James Kwok, the London-based head of currency management at asset manager Amundi Asset Management, which oversees $1 trillion.

“Norges Bank has downplayed inflation as a key factor substantially and remained more dovish than the market expects,” Kwok said by e-mail.

Options traders have become increasingly pessimistic about Sweden’s krona since last month’s meeting of the Riksbank, where policy makers discussed lowering borrowing costs.

The premium for contracts betting on a gain in Sweden’s currency against the krone, versus wagers on a decline, narrowed to 0.17 percentage points, from a 3 1/2-year high of 0.28 percentage points on Feb. 12, according to the three-month 25-delta risk-reversal rate compiled by Bloomberg.

Global Concerns

The prospect of deflation, or falling prices, is a concern for policy makers across the developed world.

Consumer prices in the euro area rose an annual 0.8 percent in February, below the European Central Bank’s 2 percent target for a 13th month. ECB President Mario Draghi said after a Group of 20 meeting in Sydney last month that he’s ready to boost stimulus measures if the price outlook deteriorates.

The minutes of the U.S. Federal Reserve’s January meeting showed officials were concerned that the inflation rate, which accelerated to 1.6 percent that month from 1.5 percent in December, was too low. Some members wanted an “explicit indication” in the annual statement on U.S. policy goals that inflation persistently below the 2 percent target would be “equally undesirable” to a pickup in prices.

Danske Bank A/S, Denmark’s biggest lender, raised its target for Norway’s krone versus the krona last week, citing the diverging inflation outlook. The krone will gain about 2 percent to 1.095 kronor, the Copenhagen-based bank predicted, compared with a previous estimate of 1.08.

There’s a 69 percent probability the krone will rise to that level against the krona by year-end, up from 44 percent at the start of February, options data show.

“We have concerns for the euro zone in terms of deflationary pressure, and that’s also something that we see happening in Sweden,” Christin Tuxen, a senior analyst at Danske Bank in Copenhagen, said in a phone interview yesterday. “We see a risk -- we don’t necessarily think it’s going to happen -- that the Riksbank may cut rates later in the first half of the year. We don’t see the deflationary pressure coming through in Norway to the same extent.”